Alarm goes off over austerities sought by senators for student loans.

WASHINGTON - Cuts in the federal Guaranteed Student Loan program proposed by a Senate education committee could make profit margins too tight for many banks to keep making loans, lobbyists and state education officials say.

If many of the 7,800 banks that now make student loans were to leave the business, that would presumably lessen the need for tax-exempt student loan bonds. State education authorities use bond proceeds to purchase the federally guaranteed loans from the banks.

The reductions proposed by the Senate Labor and Human Resources Committee, if enacted, would hobble the student loan program just when it needs to look its best, lobbyists and education officials say.

That is because the committee is also proposing to create a program of direct student loans made by colleges that would coexist with the current system for the next four years. In 1997, Congress would have to choose which system would survive.

"The private sector is going to look bad here," said a government official who requested anonymity. "Banks aren't going to lend money if they can't make a normal profit out of it." with the result that "we're going to find ourselves without enough capital in the market."

The cuts in the current system were approved by the committee June 10 in response to a directive from congressional budget writers to find $4.3 billion in savings among the programs under the committee's jurisdiction. The direct loan proposal was also approved as part of that cost-cutting initiative.

The panel's measure is part of a larger budget and tax package, known as the budget reconciliation bill, that the Senate began debate on yesterday. The Senate is expected to take a final vote on the package later this week.

The cost-cutting measures include lowering the yield banks receive on student loans to 2.5 percentage points above the current rate on Treasury bills, from the current 3.1 points. Under the proposal, the federal government would also be permitted to charge a number of user fees, such as a 0.25% transfer fee for any loans sold by one holder to another.

The result is that banks are "not going to get adequate compensation for administrative costs," said the government official.

"With that level of cuts, the large majority of banks will likely exit the program [because] it will certainly be extremely difficult to make money out of it except for.the very largest institutions." said Fritz Elmendorf, vice president of communications for the Consumer Bankers Association.

The House version of the reconciliation package does not contain the cost-cutting measures devised by the Senate committee. That is because the House Education and Labor Committee derived nearly all of its $4.3 billion in savings from its version of a direct lending proposal.

Under the House bill, direct lending would be fully phased in after four years, while in the Senate committee version, only 50% of total student loan volume would come from direct loans by the end of that period.

Another difference is that the House bill would permit an automatic switch to full direct lending after four years, while the Senate committee proposal would require Congress to study both programs and determine which one is better.

The Senate panel scaled back its direct lending plan to answer the concerns of committee members who feared moving too quickly to implement the new system. But advocates worry that the current system would be weakened by the cuts that the panel included to reach the $4.3 billion savings mark.

"One of the areas that we have been concerned about has been that, if there is a policy decision made to switch to direct lending, the [viability of the current] program in the meantime has to be assured, so that there isn't a failure to provide lending to students" in the next four years, said Larry O'Toole, the president of the New England Education Loan Marketing Corp.

"The Senate bill and its cuts, I think presents some challenge to that," O'Toole said. "It would cut the current program substantially during the transition period."

Another state official said he was also concerned about cost-cutting measures aimed directly at the education authorities. For example, many state agencies now charge students an administrative fee of up to 3% on loans, but the Senate committee has proposed capping the fee at 1%.

"As much as the cost provisions are needed, I think they're going to make it very difficult for some agencies to survive," said Donald Vickers, executive director of the Vermont Student Assistance Corp.

Gary Rieman, a student loan official in Illinois, said he is also worried about the future.

"There clearly are [loans] in the pipeline for us to purchase [but] we are in a different environment today than we would have been if there weren't such substantial changes proposed," said Rieman, who is director of the Illinois Student Assistance Commission's Illinois Designated Account Purchase Program. "We know the business in the future isn't going to be the same."